Financial Sector Assessment Program United Kingdom Technical Note: The Institutional Framework for U.K. Financial Stability Policy

This technical note reviews the Financial Sector Assessment Program of the United Kingdom. It examines the United Kingdom’s public debt management practices using the IMF-World Bank Guidelines for Public Debt Management as a framework. It analyzes the government’s Code for Fiscal Stability, transparency, accountability, debt strategy, and risk management framework. It also provides a detailed assessment of the antimoney laundering and combating the financing of terrorism regime and compliance of the Basel Core Principles of the United Kingdom.


This technical note reviews the Financial Sector Assessment Program of the United Kingdom. It examines the United Kingdom’s public debt management practices using the IMF-World Bank Guidelines for Public Debt Management as a framework. It analyzes the government’s Code for Fiscal Stability, transparency, accountability, debt strategy, and risk management framework. It also provides a detailed assessment of the antimoney laundering and combating the financing of terrorism regime and compliance of the Basel Core Principles of the United Kingdom.

I. Introduction1

1. The new framework for financial stability was set out in the 1997 Memorandum of Understanding between HM Treasury, the Bank of England, and the Financial Services Authorities. A new legal framework for financial sector regulation and supervision came fully into effect from November 30, 2001. Under the Financial Services and Markets Act 2000 (FSMA), which replaced the 1987 Banking Act and other financial services legislation, the U.K. has now moved from a regulatory structure with multiple regulators and a complex range of statutes, to a single regulatory agency with responsibility for virtually all financial sector businesses (the Financial Services Authority, FSA) and one governing statute. In terms of financial stability policy, then, the FSA is responsible for regulating, in particular, deposit taking, insurance and investment business in terms of the objectives set out in FSMA (see below), as well as responsibility for the regulation of clearing and settlement systems. This covers both prudential supervision as normally understood, and conduct of business regulation (unlike some other sectorally integrated supervisors in other countries). The Bank of England (BoE) has a broader financial system stability objective, plus prime responsibility for payments system oversight. The U.K. Treasury (HMT), meanwhile, as the central economic and financial advisor to Government, has a general oversight role for financial stability policy and arrangements at a higher level, including as to the institutional set-up and legislation.

2. The creation of FSA as an autonomous organization, undertaking public policy functions,2 predates FSMA by several years, and is associated with the separation of banking supervision functions from the BoE at the time when the latter gained monetary policy “instrument” independence. There has of course been a reasonably extensive debate for some time about the merits or otherwise of placing or keeping the banking supervision function in the central bank; as well as, more recently, about the merits or otherwise of integrating supervision of the various financial market segments within a single institution, be it the central bank or another organization.3 At the conceptual level, the debate makes clear that there are arguments for and against each side of those issues, and that the relative empirical importance of each argument is likely to depend importantly on country circumstances. Therefore, while individual country circumstances may point more toward one structure than another, for policymakers the real issue is the need to find mechanisms which best manage a number of potentially important trade-offs that underlie the arguments on both sides of the conceptual debate. Amongst the most important of these is the need for coordination and information-sharing among the organizations responsible for financial stability. In other words, and cliché though it may be, the devil is undoubtedly in the details.

II. Focus, Accountability, and Coordination in the United Kingdom Context

3. In the United Kingdom, the most important overall judgment lying behind the establishment of the current institutional structure appears to have been that there were net gains to be made in the efficiency and effectiveness of financial sector supervision and regulation given:

  • the continuing growth in the importance of financial conglomerates and the continuing blurring of distinctions between financial products and institutions; and

  • the economies of scale and scope for an integrated regulator, e.g., in terms of being able to allocate scarce regulatory resources more easily amongst competing needs.

4. In addition, although clear objectives and sharpened accountability would be desirable under any institutional structure, there is an argument that this may be more easily achieved under the current institutional structure than under the previous one.4 For example, at the level of a central bank with both monetary policy and bank supervision responsibilities, this is not so much an issue about a potential conflict between the objectives of these two functions; but rather an issue of whether these two quite different but very important responsibilities may involve a loss of focus at the overall organization level, as the issues in either area may distract management attention from the other.

5. Nevertheless, many of the opposing considerations have also been taken into account in the United Kingdom, and substantial thought has gone into how to make the new institutional structure work well, so that the anticipated advantages are realized. To this end, a variety of mechanisms have been established to help minimize and manage the tradeoffs. Perhaps the most important and visible institutional instrument for this purpose is the 1997 Memorandum of Understanding (MoU) between the BoE, FSA, and HMT.5 The next section discusses mechanisms at the level of the FSA itself.

6. The MoU spells out in some detail the different roles and focuses that the three organizations will pursue towards the joint objective of promoting financial stability, both in a crisis situation and more generally. It stresses that each institution must be accountable for its performance in respect of those responsibilities, and that transparency is needed. As discussed in the detailed assessments of transparency practices for the BoE and FSA, transparency practices are indeed very strong in the United Kingdom.

7. While there is an emphasis on avoiding duplication on the one hand, the tripartite MoU also creates a strong framework for information exchange and effective coordination, on the other. It establishes the high level financial stability Standing Committee (FSSC) for regular discussions, and for emergency consultations in a crisis; it records that the BoE’s Deputy Governor for Financial Stability will be a member of the FSA Board, and the FSA Chairman a member of the BoE “Court”; and requires that “at all levels, there will be close and regular contact” between the FSA and BoE, including through a program of mutual secondments. Moreover, from the FSAP mission’s discussions with the U.K. authorities, it is clear that there is a rather long list of more or less formal channels for coordination and information exchange in addition to those specifically mentioned in the MoU.

8. It is important to note that the MoU goes on to state clearly that the FSA and BoE “will establish information sharing arrangements to ensure that all information which is or may be relevant to the discharge of their respective responsibilities will be shared fully and freely (emphasis added). Thus, once identified by one party as relevant to its responsibilities, the requisite information would need to be shared promptly (subject only to applicable confidentiality requirements as regards further release). The FSAP mission puts considerable store on the importance of effective information exchange and coordination in this context, and believes that the MoU framework in the United Kingdom provides strong incentives to ensure that this happens. In this environment, any coordination or information sharing glitches that might occur should be no more than second-order administrative issues to be quickly fixed by managers.


9. The role and performance of the FSA as the first fully integrated regulator in a major economy has attracted world-wide attention. The organizational restructuring involved in combining and regrouping up to 11 predecessor agencies has itself been a major, if still incomplete, accomplishment. The changes in the supervisory regime, however, go well beyond the consolidation of multiple separate agencies into a single organization. The FSMA represents a comprehensive update of U.K. financial supervision legislation. It consolidates authority for financial supervision under the FSA, and it gives the FSA broad new statutory authority to carry out its responsibilities. Statutory regulation has displaced most of the self-regulatory arrangements that had been a traditional feature of U.K. financial markets. With its four statutory objectives and seven principles of good regulation (see below), the FSMA has also reoriented the U.K. approach to financial regulation. Reducing financial crime and ensuring appropriate consumer protection have been made explicit statutory objectives.

Traditional prudential objectives such as depositor protection and investor protection remain in the objective of “appropriately protecting consumers”, but are set alongside the broader, more general objectives of maintaining confidence in the financial system and promoting awareness and understanding of the financial system. The traditional U.K. emphasis on strong governance by regulated parties and a preference for minimally prescriptive regulation has been retained.

10. Although it is a large and relatively complex statute addressing a broad range of areas, the FSMA generally provides only a framework within which the FSA is to prepare more detailed rules on the various issues covered. One of the most important powers delegated to the FSA is thus the power to produce Rulebooks governing the contents of FSMA. After lengthy consultation processes, the FSA has produced a handbook that supplements the general powers given to the FSA under FSMA and sets out in detail Rules relating to individual areas of regulated activity.

11. More specifically, the new framework consists of three levels of regulations: (i) Primary Legislation—i.e., the FSMA itself: beyond the objectives outlined above, the FSMA contains seven principles of good regulation, the FSA powers and functions, the applicable accountability mechanisms, etc.;6 (ii) Secondary Legislation, that comprises a set of acts that regulates different aspects of FSMA in a more precise way (e.g., FSMA refers to regulatory activities but never defines them; they are defined in the secondary legislation)—there are around 90 pieces of such secondary legislation; and (iii) the FSA Handbook, that collects all the regulations issued by the FSA.

12. FSMA identifies four regulatory objectives for the FSA, which cover conduct of business aspects, as well as purely prudential supervisory/financial stability issues:

  • maintaining confidence in the financial system;

  • promoting public awareness and understanding of the financial system;

  • appropriately protecting consumers of financial services; and

  • the reduction of financial crime.

13. In addition, in pursuing these four objectives, the FSA must also take into account seven “principles of good regulation.” They are as follows:

  • minimizing adverse effects of regulation on competition;

  • encouraging competition among firms regulated by FSA;

  • using its resources economically;

  • taking account of the responsibilities of those who manage the affairs of authorized persons;

  • following the principle that a burden or restriction imposed on a regulated firm should be proportionate to the benefits expected;

  • being attentive to facilitating innovation in connection with regulated activities; and

  • observing the international character of financial services and markets and the desirability of maintaining the competitive position of the U.K.

14. The distinction between the four statutory objectives and the seven principles is important. Since the latter are to be taken into account, rather than directly pursued by FSA, the formulation establishes a clear sense of priority between the two sets of criteria, to guide both implementation by the FSA of its responsibilities, and the internal and external accountability processes. For example, if the principles related to competition had been enshrined as an objective rather than as matters for consideration (as proposed at one stage during the process of enacting FSMA), it is not difficult to conceive of situations where, in the short term at least, there could have been quite sharp conflicts between, say, a competition-oriented objective and a market confidence objective.7 In addition, a competition objective under FSMA would have cut across the competition-related objectives of other parts of the U.K. government, tending to dilute accountability.

15. Nevertheless, the fact that the seven principles are explicitly spelled out in the law is a significant innovation that reflects the complexity of the issues in financial stability policy. Most if not all jurisdictions would acknowledge that, e.g., supervision and regulation should not negate the responsibilities of owners and managers of financial institutions, nor should supervisory policies and actions be unduly burdensome or restrictive. But having these consideration explicitly set out in FSMA serves to bring such considerations into sharp relief, and “gives them some teeth.” The legal framework requires FSA to quite clearly account for its action to meet its objectives, in terms relevant to the principles—one specific example where this part of the framework “bites” is in the derived obligation for FSA to produce explicit cost-benefit analyses for its regulatory policies and actions. Just as important, it is also a strong signal to those to whom FSA is accountable—including Government, Parliament, the general public, the industry and in some cases the courts—about what should be expected of the FSA and what should not.

16. None of the above is to deny that there may still be conflicts or tensions between the objectives and principles. For example, even if there are no fundamental inconsistencies between the four objectives, it is conceivable that there may be tensions between, say, responsibilities related to the financial stability aspects of the objectives, and those related to the conduct-of-business or financial crime aspects. These may be felt at the level of the higher-level organizational focus (the “distraction” issue), especially if problems in the latter areas are prone to become politicized; or at the micro level of resourcing. By way of comparison, and as noted above, one of the arguments advanced for separating banking supervision from a central bank focused on price stability is the potential distraction value of problems in the former that can become quite politicized.8 As we interpret it, the empirical judgment that the U.K. authorities are making here, at least implicitly, is essentially that, in the United Kingdom, the synergies between prudential and other forms of financial sector regulation outweigh any such risks, provided the legal and institutional framework for the integrated regulator is strong enough. At the same time, it is important to work hard to ensure that coordination and communication between, for example, the Bank of England and the FSA ensure that other synergies (e.g., between banking supervision and monetary policy) can be exploited even if responsibility for these two functions is split between two different institutions.

17. The proviso above, about the strength of the legal and institutional framework, is critical. If trade-offs between different objectives and constraints are to be well made within one organization, transparency, accountability and governance arrangements need to be well designed. In our view, the FSA meets this criterion.9 As already noted, transparency practices are very strong. The FSA has been exemplary in formulating and outlining how it is approaching its tasks, in its corporate plan and annual report, as well as in a range of more ad hoc publications (such as its Progress Reports.) Further, the FSA is required to consult quite extensively and publicly on proposed rules and regulatory guidance.

18. In addition to transparency aspects per se, there are numerous checks and balances in the FSA’s governance structure. For example,

  • though the FSA Board currently contains some appointees from the financial services industry, it also contains some appointees with other business or consumer backgrounds so that there is a balance between practitioners and others, with a majority of non-executive directors required. And in any event, the deliberations of the Board are tied back to the objectives and principles under FSMA, as well as to the U.K.’s principles of good corporate governance.

  • likewise the role of government in Board member appointments (and their removal) is constrained both by FSMA and the established, published procedures for public appointees;

  • FSMA formalized the operation of two additional advisory panels for the FSA, a Practitioner Panel and a Consumer Panel, so that both sides of the financial services industry have a channel to formally feed their views to the FSA Board, through reports which they also make public. (These two panels had actually been established by the FSA some time previously.)

  • The exercise of FSA’s wide supervisory powers are, or can be, reviewed in several ways: by an independent Tribunal for case-related decisions; by an independent FSA Complaints Commissioner who can report publicly on findings and recommend payment of compensation by FSA in appropriate cases; by governmental agencies dealing with competition (with respect to competition implications of FSA policies); and through “value-for-money” audits or specific independent inquiries that the government can commission.

19. To make more concrete the application of its statutory objectives and regulatory principles, the FSA has elaborated an operational framework—it’s “risks to our objectives” (RTO) framework—for setting supervisory priorities and allocating scarce supervisory resources. (See Box 1.) The framework facilitates consistency, transparency and accountability in the implementation of supervisory responsibilities. Consistent with that framework, the FSA’s emphasis on further development of its insurance supervision framework (Box 2) is one illustration of how supervisory priorities and associated resource reallocation can work within the FSA, as an integrated supervisor.

20. The guiding principle that similar risks should be regulated in the same way, regardless of type of institution, is giving a strong impetus to integrating FSA rules as well as its organization and processes, although this is still at a fairly early stage. Implementation of the FSMA has allowed the FSA to introduce a single enforcement regime applicable to all firms and individuals it regulates. The new regime sets out which regulated activities require authorization, and the FSA authorizes firms by giving permissions defining which activities they can carry out. The FSA has developed an authorization process that applies across all sectors, and it includes giving approval to individuals responsible for key designated duties in authorized firms. Development of the authorized-persons regime is also giving the FSA an important tool for implementing its supervisory strategy which looks to firms’ directors and management to take responsibility for compliance with rules and regulations. Conduct-of-business rules have been developed that apply across all regulated firms. Prudential requirements across banks, insurance companies, and independent securities firms remain quite distinct, although projects are underway to achieve greater harmonization. The fundamental review of insurance supervision referred to above may well lead to adoption of elements of the risk-based strategies used in the regulation of banks. Reporting requirements are also undergoing a systematic re-evaluation that is likely to lead to more commonality across financial sectors.

The FSA’s Risk to Our Objectives Framework

The FSA’s RTO approach is in essence a form of corporate planning framework for establishing supervisory strategies, guiding the FSA’s work program, allocating supervisory resources, designing regulations, and evaluating the effectiveness of supervisory efforts. It should be distinguished from what is normally thought of as risk-based supervision, which focuses on the risk exposures of individual firms, such as credit risk, liquidity risk, market risk, operational risk, litigation risk, without explicit reference to higher-level supervisory objectives. The FSA approach, in contrast, considers the risks posed by regulated individuals and firms, and by industry-wide developments, to the achievement of the FSA’s four statutory objectives. Reflecting this, under the RTO framework, the risks of primary concern to the FSA are the risks that developments in firms or markets will undermine market confidence in the financial system, that financial institutions and individuals will be subject to abuse by criminal elements, or that uninformed individuals will be mislead by financial operators. To the extent that the priorities between the FSA’s broad objectives shift over time, it can be expected that this would be reflected fairly explicitly, through the RTO framework, in the FSA’s corporate plan, annual report, and other publications. However, this has yet to be fully tested.

To make the RTO framework operational and to allow it to be applied consistently across all firms, the FSA has developed a classification scheme that links firm risk and environmental risk to the risks to its objectives. The FSA has identified seven high level risk groups linked to one or more of the four statutory objectives. The seven risk groups are: financial failure, misconduct/mismanagement, consumer understanding, incidence of fraud or dishonesty, market quality, incidence of market abuse, and incidence of money laundering. Firm specific risk is divided into two broad categories: business risk and control risk. These categories, in turn, are subdivided into some 40 risk elements. Based on a risk assessment, firms are categorized as High Impact, Medium High Impact, Medium Low Impact, or Low Impact. This categorization, in turn, determines the nature and intensity of the supervision of individual firms by FSA. Firm size is not the exclusive factor in determining where a firm lies on the spectrum between high and low impact, but it is a central factor.

The RTO approach still allows room for flexibility and judgment in its application, however. For example, the risk analysis that leads to the categorization of individual firms is, unavoidably, highly subjective; nor does the framework itself provide much operational guidance for determining, overall, how much supervision is enough or which risks are most important for which firms. At the firm level, the supervisory strategies adopted by FSA appear to be guided as much by conventional risk assessments (credit, liquidity, interest rate, operational, litigation, etc.) as by the RTO factors. Beyond that, judgments about supervisory policies are shaped by the requirement to undertake explicit cost-benefit analyses for material proposals, as well as the broad consultation requirements. In short, the RTO framework, while certainly not providing all the answers itself, does help to make the operation of supervision more consistent, more open, and more open to challenge at several levels.

The Further Development of Insurance Supervision in the U.K.

The U.K. authorities are in the process of significantly strengthening insurance supervision and are shifting resources within the FSA to insurance sector oversight. This is appropriate in light of the importance of U.K. insurance companies and markets in both the U.K. financial system and the global insurance industry, as well as the highly sophisticated nature of the U.K. market. It is also particularly timely given the significant current stress in the industry and the potentially strong incentive for excessive risk taking in the current environment. The state of the industry has required the FSA to grapple with the more immediate “bushfires” arising from the current situation—reflected in increased supervisory activity, including enhanced monitoring of insurers’ financial modeling, and modifications and temporary suspensions of the FSAs “resilience tests” for insurers (to avoid “fire-sale” problems from forced asset sales)—at the same time as it progresses forcefully the more fundamental but more medium-term task of overhauling the supervision regime.

The FSA had already begun developing a strengthened approach to insurance supervision under its risk-based framework (the “Tiner project”) at the time of the FSAP assessment of the U.K. insurance supervision and regulation regime against the IAIS Insurance Core Principles, and the early implementation stages have proceeded further in the interim. 1/ The FSAP assessment was therefore able to give further encouragement to the reforms proposed under the Tiner project, as well as suggesting a few other additional measures for consideration. The main findings (at the time of the FSAP assessment at least) included that the FSA’s regulatory and prudential regime required an increased degree of hands-on prudential supervision and was not sufficiently proactive; reflecting in part the absence of formal actuarial, general insurance, and reinsurance involvement in the risk review and assessment process, the current prudential regime may not ensure a sufficiently comprehensive review of the appropriateness of firms’ risk management systems, asset allocation limits, and internal controls, in light of the nature and amount of business underwritten; 2/ and the desk-based analysis of statutory returns may not adequately capture the nature and scale of risks of underlying asset and reinsurance exposures. The authorities were encouraged to consider a further strengthening of insurance supervisory resources and processes within the FSA. In addition, the assessment also stressed the need for improved transparency of early intervention actions was stressed, and stronger reporting, disclosure, and governance-related requirements for insurance companies. 3/ The reforms planned under the Tiner project are expected to remedy most of the shortcomings noted in the assessment of observance of the (enhanced version) of the IAIS Principles.

One further issue, closely related to the abovementioned weaknesses, is the dearth of timely, public aggregate financial indicators for the U.K. insurance industry (as, indeed, in many other countries).

The FSAP team drew also on aggregated data and analyses available (at a price) from private market participants, but even the most recent of these were quite dated. Stronger reporting and disclosure will hopefully facilitate better availability of financial soundness indicators for the insurance sector, which is a high priority for further strengthening the overall surveillance of the U.K. financial system.

1/ More specifically, the formal assessment was against higher standards applicable to a major insurance center like the U.K., rather than the regular standards.2/ More recently, however, the FSA has integrated into its supervision team the previous work of the Government Actuary’s Department (GAD).3/ See the FSAP detailed assessment of the IAIS Insurance Core Principles for a full description.

IV. The Bank of England’s Financial Stability Role

21. The MoU clearly recognizes that core central banking functions are as much a part of the overall financial stability regime as the more institution-specific supervision functions. Indeed, the whole pursuit of monetary (price) stability is itself a cornerstone of financial stability in its broader sense. And at a somewhat narrower level, the arrangements to manage liquidity at a system-wide level to ensure key financial markets continue to function effectively, even in time of stress, are the same arrangements that are required to undertake effective and efficient monetary policy. (Systemic liquidity arrangements are discussed in detail in another FSAP Technical Note.)

22. In addition to those aspects of the BoE’s core functions, the MoU also stresses the BoE’s central role in advising on, overseeing and helping to implement appropriate changes in the payments system infrastructure; in undertaking surveillance of the financial system as a whole; and, in exceptional cases, undertaking last resort lending of one form or another. The payments system responsibility stems quite naturally from the BoE’s role as “bankers’ bank” and its provision of the central settlement asset underpinning the whole infrastructure. The system—level surveillance role, including a major component related to surveillance of international financial market activity (given London’s role as a major international financial center), stems from the BoE’s ability to supplement the institution-by-institution perspective with a perspective drawn from financial markets and payments systems (where, e.g., more system-level issues and budding crises can often be perceived earliest); and from the international and domestic analysis and forecasting that is necessary to underpin the day-to-day formulation of monetary policy. One further financial stability function of the BoE that can be noted is its role in facilitating corporate workouts under the “London Approach”. This is less common now than it was several years ago, but nevertheless, the BoE stands ready to help facilitate a London Approach workout if requested, as it has in several cases in the past.

23. While it cannot be definitively linked to the institutional reforms of 1997–98, there has been a distinctly sharper focus in recent years on broader financial sector trends, issues, risks and vulnerabilities by the BoE; a process of constant improvement and innovation in this area has been underway. This is most clearly seen in the development of the BoE’s six-monthly Financial Stability Review (FSR), which has progressed from its early form as a somewhat ad hoc collection of articles on stability-related topics10 to a comprehensive and well-presented compendium of conjunctural and structural/institutional trend and issues. The FSR also reflects the BoE’s considerable efforts in international market surveillance, and possible linkages back to the U.K. financial system (see Box 3). As demonstrated, inter alia, in this publication, financial sector surveillance in the United Kingdom, in the FSAP mission’s view, is at the forefront internationally.

24. Nevertheless, the agenda for further strengthening financial sector surveillance in the United Kingdom contains some significant tasks. One key task is to extend and deepen the knowledge of inter-intitutional exposures, especially in regard to unsecured interbank funding. These exposures relate to both explicit exposures between banks in the interbank market per se, and possibly less explicit, intraday exposures between indirect clearing banks and their direct clearing sponsor banks.11 An analysis in the June 2002 FSR12 made a major first step in analysis of such exposures, and we encourage the BoE to continue to give a high priority to improved monitoring and analysis in this area. A similar issue is the potential interinstitutional exposures in derivatives markets, not least the risk transfer markets.13 These will likewise need close monitoring, both in the institution- or market-specific supervision context, and in the broader system-wide surveillance context.

25. A second important area is the need to continue pushing ahead with improvements to the quality and timeliness of aggregate financial soundness indicators (FSIs) for the United Kingdom. This is not straightforward given the variety of existing data that has been developed historically, with different objectives in mind and with different institutional coverage. But again, recent work published in the FSR have been important steps forward,14 and the BoE has been actively engaged in broader efforts to make progress in this area at the international level as well. The FSAP team encouraged continued work in this area, and stressed, inter alia, the desirability of producing timely official FSI data for the insurance sector. As noted in Box 2, the significant proposed changes to the insurance supervision regime (the “Tiner Report” project) should facilitate this.

The Bank of England’s Financial Stability Report

In their detailed analysis of the financial stability “conjuncture and outlook”, the 6-monthly FSRs seek to identify and track potential risks to the U.K. financial system arising from macroeconomic, macrofinancial, and infrastructural developments in global financial markets and major economies or groups of economies (e.g., U.S., Europe, Japan, emerging markets), and from within the U.K. itself. Following the assessment of international and domestic risk factors, analysis of the U.K. financial system, including aspects of the underlying financial stability polity framework, then seeks to assess how resilient or vulnerable the system might be to the risks, should they eventuate. (This distinction between risks and vulnerabilities is one that the FSAP mission also finds a helpful construct.) Increasingly, these analyses have examined different sectors and peer groups within the U.K. system, and the interlinkages between them. They have also put some emphasis on the need to look at the distribution of strengths and weaknesses across the system, rather than simply the overall aggregate or average position.

Apart from the conjunctural analysis, FSRs have included individual stability-related articles on a wide range of topical matters. To illustrate, the June and December 2002 FSRs included special articles on U.K. bank exposures (data sources and interpretation); U.K. bank provisioning; spillovers from emerging markets crises; state of play, and implications of “Basel II”; effects of market risk management systems; “dynamic provisioning”; renewing market confidence in the wake of recent high-profile corporate and accounting problems, and the nature of different measures of corporate earnings; insolvency law; resolving financial crises; risk modeling in central counterparty clearing houses; and U.K. interbank exposures. The FSAP team found many of these and earlier FSR articles very useful background for its own work.

26. A third area, also already underway within the BoE, is the strengthening of quantitative analysis of the aggregate indicators of the financial sector, including through linking these in to the BoE’s macroeconomic model. BoE work fed importantly into the design and calibration of the “stress testing” scenarios used by banks as part of the U.K. FSAP exercise, as well as into the authorities’ own “top-down” stress analysis, with related work again depicted in the June 2002 FSR.15 Again, the FSAP team encouraged further work of this sort so that some form of system-wide stress testing analysis could develop into a fairly standard part of financial sector surveillance in the United Kingdom.


This paper was prepared by the FSAP mission team as part of the background work for the U.K. FSAP in the summer-fall of 2002. The primary contributor to this paper was Mark Swinburne of the IMF’s Monetary and Financial Systems Department.


More formally, FSA is an independent non-governmental body, given statutory powers under FSMA; its legal form is as a company limited by guarantee, and it is financed by the financial services industry. FSA’s Board, comprising an executive Chairman, three other executive Directors, and 11 non executive director, is appointed by HMT, with a process outlined in the “Nolan procedures” for public appointments. In addition, the FSAP team understands that in future, the positions of FSA chairman and chief executive will be separated.


See, inter alia, Richard K Abrams and Michael W. Taylor, Issues in the Unification of Financial Sector Supervision, IMF Working Paper WP/00/213, 2000; and, for a more U.K. FSA perspective, Clive Briault, The Rationale for a Single National Financial Services Regulator, FSA Occasional Paper No. 2, 1999.


For a more recent discussion for the U.K., see e.g., Clive Briault, Revisiting the Rationale for a Single National Financial Services Regulator, FSA Occasional Paper No. 162002.


The full text of the MoU can be found on official websites—e.g., at


In this context, the FSA chairman is appointed/removed by the Treasury, so that the chairman is not as formally independent as in the sense commonly advocated for an independent central bank. As discussed more fully in the detailed standards assessments, however (especially the transparency assessment), there are, nevertheless, some other important constraints in the U.K. system that help ensure that appointments and removals do not become unduly political matters.


Even if, in the medium-longer run, there may be no conflict between the two objectives: as in the time-inconsistency argument for a single price-stability objective for monetary policy, it is often the short-term trade-off that matters for performance over time.


More formally, this can be seen as a need to manage additional reputation risks to minimize any negative spillover to monetary policy credibility.


Briault (2002), op. cit, contains a more detailed discussion of the mechanisms.


The FSR was first published in Autumn 1996.


These transactions do not benefit from the risk reduction/transparency arrangements under RTGS, which directly effects only the clearing banks.


See especially Box 11, p. 93.


See the articles by David Rule in the December 2001 FSR “Risk Transfer Between Banks, Insurance Companies and Capital Markets: an Overview,” and the June 2001 FSR “The Credit Derivatives Market: Its Development and Possible Implications for Financial Stability.”


In particular, the articles in the June 2002 FSR by Andrew Gracie and Andrew Logan, “U.K. Bank Exposures: Data Sources and Financial Stability Analysis”; and by Glen Hoggarth and Darren Pain, “Bank Provisioning: the U.K. Experience”.


See the article by Hoggarth and Pain referenced in the preceding footnote.